Did a China Indicator Lead the Market Down?

A once-obscure indicator from the Conference Board has managed to capture global headlines less than two months after it was published for the first time.

Unfortunately for the New York-based organization, the attention has centered on the downward revision in its China leading economic index for April, after the group admitted to a mistake in its previous calculations.

Much market commentary blamed the change for Tuesday’s 4.3% fall in China’s benchmark Shanghai Composite Index — which was followed by declines in other global markets, including the Dow’s 2.6% drop. The blogger known as Tyler Durden even headlined his take on the news “Massive Downward Revision of China Leading Economic Index Refutes China ‘Recovery’ Myth.” (The revision doesn’t seem to have actually changed his pessimistic take on the Chinese economy.)

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But as always with markets, multiple explanations are possible: Rachel Ziemba of Roubini Global Economics said the fall in Shanghai was more likely due to reduced liquidity.

The Conference Board’s leading indicator for China — like the ones it calculates for other countries — is based on publicly available data published by the Chinese government, but the correction didn’t reflect any change in the underlying data. “A human error occurred when reformatting the official data for April. There’s a lot of transformations that need to happen to the Chinese data to make them directly comparable to the indicators we use in other LEIs,” explained Bill Adams, the Conference Board’s resident economist in Beijing.

AFP/Getty Images

Watching the stocks in Taipei.

The idea that global markets were being driven by such statistical flukes seemed particularly frustrating to Bank of America-Merrill Lynch economist Ting Lu. On Wednesday he unleashed a vicious — by the standards of economists, anyway — critique of the methods used to generate the indicator. In addition to the error the Conference Board admitted and corrected, Lu alleged other several statistical mistakes, saying the group’s analysts “might misunderstand” or “may fail” to do certain procedures. He didn’t provide evidence that any specific error had actually been made, but urged investors to discount the indicator.

Asked to respond to Lu’s report, Bill Adams of the Conference Board said: “The China LEI is made according to a transparent and internationally comparable methodology, and we welcome comments from the analytical community on our methodology.”

The most mysterious part about the brouhaha over the correction by the Conference Board is that it does not actually represent a major change in the outlook for China. The revision pushed the six-month annualized rate of change in the index down to 6.8% in April from the original 9.9%. The new rate is the same as January’s — which shows that the corrected number is in line with the recent trend. The LEI has been signaling a slowdown since December.

Notably, the erroneous high reading had no discernible effect on global markets when it was announced, on June 15 — adding to the mystery of why some investors suddenly saw its revision as a cause for alarm. Hong Kong’s benchmark Hang Seng Index rose just 0.05% that day, and commentators didn’t mention the China LEI as a factor in trading there or elsewhere. Mainland China’s markets were closed then for a holiday. When they resumed trading two days later, the Shanghai Composite fell.

It was the LEI’s original, high, mistaken reading for April that was out of step with the broader slowing trend in China’s economy. At the time of the original release, the Conference Board struggled to explain the figure, and warned — correctly, as it turned out — that the bump would be “transitory.”

“The Conference Board’s correction to the LEI, although regrettable, brings the index into line with what we’ve been forecasting for months, which is that growth is going to moderate after the post-crisis cyclical bounce-back,” Adams said.

For those who’ve been paying attention, it’s clear that the Chinese economy has been slowing since the second half of last year as the authorities began to scale back their stimulus programs. And growth is universally expected to slow even more in the rest of 2010, in part because of the government’s move in April to cool down the property market.

That is likely to result in weaker construction activity in coming months, though not much of a slowdown is yet apparent in the latest economic data for May. If Tuesday’s selloff in global stocks is anything to go by, markets may not have yet fully priced in the extent of the coming slowdown.

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